Reason Foundation

Source of China's Housing Bubble

The source of the Chinese housing bubble stems back to the 1990s when China began privatizing housing. The government began to sell citizens their homes for cheap and virtually overnight increase the homeownership rate from 50 percent to 80 percent. Since then, with few other investment options, the middle class has poured capital into housing. But investment has not only come from the wealthy elite or middle class families, but governments across the country. In fact, local governments own many property developers.

In many places around the country land has grown so expensive that private developers have pulled back, leaving state owned enterprises as the main investors in real estate. The national and local developers are able to operate largely apart from budgetary constraints, and are funded by state owned banks. This has left local governments exposed to potentially unsustainable debts.

While a full-on collapse of the Chinese housing bubble may be a while off, there are warning signs emerging now. For instance, despite the growth in property prices, sales volumes were down 25 percent from April to May 2010. The general consensus is that the bubble is unlikely to burst before 2011, but much depends on the success of the Chinese attempt to cool off the housing market. Beyond the down payment increases, new rules that limit the number homes that can be bought in certain cities could cause prices to drop 30 percent. Whether this triggers the loss of confidence and panic to pop the bubble depends in part on the results of the second Chinese stimulus, an 8 trillion renminbi ($1.2 trillion) monetary expansion targeted again at infrastructure set to hit in later part of 2010.

Like the U.S. housing bubble there is a difference between cities in terms of demand for different types of housing. There will be cities largely unaffected when the bubble pops, just as cities like Washington D.C. were able to largely avoid pain while Phoenix, Orlando, Las Vegas, and Los Angeles were being decimated. On a micro level the Chinese bubble is being driven by real demand in some cities, speculators in other cities, and government incentivized individual investment across the board. But on a macro level, there is a problem developing in that the supply of upper-middle class housing is high, but the supply of lower-class housing is lacking.